The Common Reporting Standard: New challenges for UK charities

Main points

New reporting obligations on financial institutions will include charities.

Grant-making charities will be particularly disadvantaged.

The Common Reporting Standard and related measures are creating new administrative concerns for charities, explains Donald Drysdale.

Background

First there was the Foreign Account Tax Compliance Act (FATCA). This is a US federal law requiring US persons to file annual reports on their overseas financial accounts. It is far-reaching because it also requires non-US financial institutions to search their records and report on assets belonging to US persons.

Then the idea of information-sharing spread even further. The OECD developed its Common Reporting Standard (CRS), an information-sharing initiative brought into effect through bilateral arrangements, requiring local domestic legislation in each participating country or jurisdiction to provide the legal framework. Each jurisdiction implementing it must have rules in place requiring financial institutions to report information and follow specified due diligence procedures.

Europe, of course, likes to do things in its own way. Inspired by the CRS, the EU’s revised Directive on Administrative Cooperation (DAC) imposes an obligation on EU member states to adopt domestic legislation to comply with mandatory requirements on the automatic exchange of information within the EU.

Note, additionally, that all UK crown dependencies and overseas territories (CDOT) have automatic tax information exchange agreements with the UK – some of them reciprocal and the others providing information only to the UK. These are expected to be short-lived as they will be superseded by the CRS.

UK compliance

The International Tax Compliance Regulations 2015 (SI 2015/878) ensure that the UK government (through HMRC) can force financial institutions to disclose information about their clients’ reportable financial accounts, and can exchange account information automatically with other jurisdictions under its various international agreements.

The regulations impose obligations on UK financial institutions to perform specified due diligence procedures to identify information about the tax residence (and US citizenship) of individuals and entities for whom they maintain financial accounts, and to maintain and report such information. They must retain that information in respect of all account holders for a period of six years from the reporting period in which it is identified, and report it to HMRC to the extent that it is reportable under any of the agreements.

The information to be reported includes interest, dividends, account balance, income from certain insurance products, sales proceeds from financial assets and other income generated with respect to assets held in the account or payments made with respect to the account. Reportable accounts include accounts held by individuals and entities (including trusts and foundations), and there is a requirement to look through passive entities to report on the relevant controlling persons.

HMRC will report each year to the appropriate parties to the agreements – namely, the 27 other EU member states, the non-EU signatories to the CRS (of which there are currently 92), and the US. In return HMRC will receive reciprocal exchanges of information from the other participating jurisdictions, which will be used to combat offshore tax evasion by UK resident taxpayers.

Differing rules and reporting obligations apply to distinct categories of financial institution in the UK. These include custodial institutions, depository institutions, investment entities and specified insurance companies, unless they present a low risk of being used for evading tax and are therefore specifically excluded from reporting. Entities that are not financial institutions are classified as non-financial entities (NFEs); they have certain reporting requirements, and these differ according to whether they self-certify themselves as active or passive NFEs.

The compliance regulations cover multiple reporting schemes, and there are varying dates for applying specified due diligence and reporting to HMRC under FATCA, CDOT, and the CRS and DAC. The reporting obligations under the CRS and DAC kick in during 2017. Penalties will apply for non-compliance.

How are UK charities affected?

The expression ‘financial institution’ is defined very broadly, so some charities – particularly endowed charities and those that receive a large proportion of their income from investments under discretionary management – may be categorised as financial institutions. Although there are exceptions for these under FATCA, there are none under the CRS and such charities may be required to make reports to HMRC.

Charities likely to be affected will need to determine into which category they will fall for the purposes of the regulations. Charities that are financial institutions will need to apply specified due diligence rules to determine whether any of the funds they hold are to be regarded as financial accounts under the regulations and must therefore be reported to HMRC. They should already be considering how they will comply with the possibly onerous new reporting requirements.

If a charity is not an financial institution it will need to assess whether it is an active or passive NFE. This will determine whether it must provide HMRC with further information in relation to its controlling persons as defined in the regulations.

Charities may receive forms from their banks or investment managers asking them to confirm into which category the charity falls for the purposes of the compliance regulations, and they may turn to their advisers for guidance on how to respond by the relevant deadline. Charities that have previously notified their FATCA classification should note that there are some specific differences between FATCA and the categories now in the regulations.

HMRC are drafting further guidance specifically for the charity sector, and this is expected to appear any day now.

Particular problems with grants

Grant-making charities are those most likely to be regarded as financial institutions. All of the individuals or entities to whom they make grants will be treated as account holders, regardless of where they are located. Thus such a charity will have to perform due diligence on all grants made.

This will require a grant-making charity to establish the tax residence of all individuals or entities to whom it pays grants – including all those located in the UK. This could be problematic; for example, persuading individual refugees to self-certify their tax status might be difficult and expensive for the charity, and in sensitive cases of political asylum it might even be harmful to the individual.

HMRC recognise that self-certification will be difficult in some cases where charities are donating to the homeless or destitute, and the new guidance is expected to allow a streamlined approach – including an assumption that an apparently homeless person is resident in the jurisdiction where they are present on receipt of the grant. Furthermore, certain gifts including food, supplies and de minimis cash amounts are likely to be non-reportable.